CHAPTER -2

Concepts of Value and Return

1. Determine the future values utilizing a time preference rate of 9 per cent:
(i) The future value of Rs 15,000 invested now for a period of four years.
(ii) The future value at the end of five years of an investment of Rs 6,000 now and of an
investment of Rs 6,000 one year from now.
(iii) The future value at the end of eight years of an annual deposit of Rs 18,000 each year.
(iv) The future value at the end of eight years of annual deposit of Rs 18,000 at the
beginning of each year.
(v) The future values at the end of eight years of a deposit of Rs 18,000 at the end of the
first four years and withdrawal of Rs 12,000 per year at the end of year five through seven.

Solution:

2. Compute the present value of each of the following cash flows using a discount rate of
13 per cent:
(i) Rs 2,000 cash outflow immediately.
(ii) Rs 6,000 cash inflow one year from now.
(iii) Rs 6,000 cash inflow two years from now.
(iv) Rs 4,000 cash outflow three years from now.
(v) Rs 7,000 cash inflow three years from now.
(vi) Rs 3,000 cash inflow four years from now.
(vii) Rs 4,000 cash inflow at the end of each of the next five years.
(viii) Rs 4,000 cash inflow at the beginning of each of the next five years.

Solution:

5. Assume a rate of interest of 10 per cent. We have a debt to pay and are given a choice
of paying Rs 1,000 now or some amount X five years from now. What is the maximum
amount that X can be for us to be willing to defer payment for five years?

Solution:

8. Compute the present value for a bond that promises to pay interest of Rs 150 a year for
thirty years and Rs 1,000 at maturity. This first interest payment is paid one year from now.
Use a rate of discount of 8 per cent.

Solution:

Solution:

15. You are planning to buy a 200 square meters of land for Rs 40,000. You will be required
to pay twenty equal annual instalments of Rs 8,213. What compound rate of interest will you
be paying?

Solution:

18. Your grandfather is 75 years old. He has total savings of Rs 80,000. He expects that he
will live for another 10 years, and will like to spend his savings by then. He places his
savings into a bank account earning 10 per cent annually. He will draw equal amount each
yearthe first withdrawal occurring one year from nowin such a way that his account
balance becomes zero at the end of 10 years. How much will be his annual withdrawal?

Solution:

20. You plan to buy a flat for Rs 200,000 by making Rs 40,000 down payment. A house
financing company offers you a 12-year mortgage requiring end-of-year payments of Rs
28,593. The company also wants you to pay Rs 5,000 as the loan-processing fee, which they
will deduct from the amount of loan given to you. What is the rate of interest on loan?

Solution:

24. Ms. Punam is interested in a fixed annual income. She is offered three possible
annuities. If she could earn 8 per cent on her money elsewhere, which of the following
alternatives, if any, would she choose? Why?
(i) Pay Rs 80,000 now in order to receive Rs 14,000 at the end of each year for the next 10
years.
(ii) Pay Rs 1,50,000 now in order to receive Rs 14,000 at the end of each year for the next 20
years.
(iii) Pay Rs 1,20,000 now in order to receive Rs 14,000 at the end of each year for the next
15 years.

Solution:

25. You have come across the following investment opportunity: Rs 2,000 at the end of each
year for the first 5 years plus Rs 3,000 at the end of each year from years 6 through 9 plus
Rs 5,000 at the end of each year from years 10 through 15.
(a) How much will you be willing to pay for this investment if your required rate of return is
14 per cent?
(b) What will be your answer if payments are received at the beginning of each year?

Solution:

29. The Madura Bank pays 12 per cent interest and compounds interest quarterly. If one
puts Rs 1,000 initially into a savings account, how much will it have grown in 7 years?

Solution:

Solution:

36. If a person deposits Rs 1,000 on an account that pays him 10 per cent for the first five
years and 13 per cent for the following eight years, what is the annual compound rate of
interest for the 13-year period?

Solution:

CHAPTER -3Valuation of Bonds and Shares

1. Suppose you buy a one-year government bond that has a maturity value of Rs 1,000. The
market interest rate is 8 per cent. (a) How much will you pay for the bond? (b) If you
purchased the bond for Rs 904.98, what interest rate will be you earn on your investment?

Solution:

3. The Nutmate Limited has a ten-year debenture that pays Rs 140 annual interest. Rs
1,000 will be paid on maturity. What will be the value of the debenture if the required rate of
interest is (a) 12 per cent, (b) 14 per cent and (c) 16 per cent?

Solution:

5. You are considering bonds of two companies. Taxcos bond pays interest at 12 per cent
and Maxcos at 6 per cent per year. Both have face value of Rs 1,000 and maturity of three
years. (a) What will be the values of bonds if the market interest rate is 9 per cent? (b) What
will be the values of the bonds if the market interest rate increases to 12 per cent? (c) Which
bond declines more in the value when the interest rate rises? What is the reason? (d) If the
interest rate falls to 6 per cent, what are the values of bonds? (e) If the maturity of two
bonds is 8 years (rather than 3 years), what will be the values of two bonds if the market
interest rate is (a) 9 per cent, (b) 6 per cent and (c) 12 per cent?

Solution:

7. On 31 March 2003, Hind Tobacco Company issued Rs 1,000 face value bonds due 31
March 2013. The company will not pay any interest on the bond until 31 March 2008. The
half-yearly interest is payable from 31 December 2008; the annual rate of interest will be 12
per cent. The bonds will be redeemed at 5 per cent premium on maturity. What is the value
of the bond if the required rate of return is 14 per cent?

Solution:

11. A fertilizer company holds 15-year 15% bond of ICICI Bank Ltd. The interest is payable
quarterly. The current market price of the bond is Rs 875. The company is going through a
bad patch and has accumulated a substantial amount of losses. It is negotiating with the
bank the restructuring of debt. Recently the interest rates have fallen and there is a
possibility that the bank will agree for reducing the interest rate to 12 per cent. It is
expected that the company will be able service debt t the reduce interest rates. Calculate
stated and the expected yields to maturity?

Solution:

12. You are thinking of buying BISCOs a preference share Rs 100 par value that will pay a
dividend of 12 per cent perpetually. (a) What price should you pay for the preference share if
you are expecting a return of 10 per cent? (b) Suppose that BISCO can buy back the share at
a price of Rs 110 in seven years. What maximum price should you pay for the preference
share?

Solution:

14. An investor is looking for a four-year investment. The share of Skylark Company is
selling for Rs 75. They have plans to pay a dividend of Rs 7.50 per share each at the end of
first and second years and Rs 9 and Rs 15 respectively at the end of third and fourth years.
If the investors capitalisation rate is 12 percent and the shares price at the end of fourth
year is Rs 70, what is the value of the share? Would it be a desirable investment?

Solution:

20. Vikas Engineering Ltd has current dividend per share of Rs 5, which has been growing at
an annual rate of 5 per cent. The company is expecting significant technical improvement
and cost reduction in its operations, which would increase growth rate to 10 per cent. Vikas
capitalisation rate is 15 per cent. You are required to calculate (a) the value of the share

assuming the current growth rate; and (b) the value of the share if the company achieves
technical improvement and cost reduction. Does the price calculated in (b) make a logical
sense? Why?
Solution:

Solution:

25. Satya Systems Company has made net profit of Rs 50 crore. It has announced to
distribute 60 per cent of net profit as dividend to shareholders. It has 2 crore ordinary shares

outstanding. The companys share is currently selling at Rs 240. In the past, it had earned
return on equity of 25 per cent and expects to main this profitability in the future as well.
What is the required rate of return on Satyas share?

Solution:

27. Gujarat Bijali Ltd has earnings of Rs 80 crore and it has 5 crore shares outstanding. It
has a project that will produce net earnings of Rs 20 crore after one year. Thereafter,
earnings are expected to grow at 8 per cent per annum indefinitely. The companys required
rate of return is 12.5 per cent. Find the P/E ratio.

Solution:

29. Sonata Company has no investment opportunities. It expects to earn cash earnings per
share of Rs 10 perpetually and distribute entire earnings as dividends to shareholders.(a)
What is the value of the share if shareholders opportunity cost of capital is 15 per cent? (b)
Suppose the company discovers an opportunity to expand its existing business. It estimates
that it will need to invest 50 per cent of its earnings annually for ten years to produce 18 per
cent return. Management does not foresee any growth after this ten-year period. What will
be Sonatas share price if shareholders opportunity cost of capital is 15 per cent?

Solution:

CHAPTER -4
RISK AND RETURN: AN OVERVIEW OF CAPITAL MARKET THEORY
1. On 1 January 2009, Mr Y.P. Sinha purchased 100 shares of L&T at Rs 212 each. During the
year, he received total
dividends of Rs 700. Mr Sinha sold all his shares at Rs 215 each on
31 December 2009. Calculate Mr Sinhas (i) capital gain amount, and (ii) total return in (a)
rupee amount and (b) percentage.

Solution:

3. You acquired Telcos 200 shares at Rs 87 each last year. The par value of a share is Rs 10.
Telco paid a dividend of 15 per cent during the year. You sold 200 shares at a total value of
Rs 18,500 after one year. What is your (i) dividend yield, (ii) rate of capital gain, and (iii)
total rupee and percentage returns.

Solution:

4. You bought Infosys share for Rs 4,250 two years ago. You held the stock for two years,
and received dividend per share of Rs 90 and Rs 125 respectively at the end of the first and
the second years. You sold the share for Rs 4,535 after two years. What was your two-year
holding period return on Infosys share?

Solution:

6. Suppose shares of Hind Ltd and Nirmala Ltd were selling at Rs 100 two years ago. Hinds
price fell in the first year by 12 per cent and rose by 12 per cent in the second year. The
reverse was the case for Nirmalas share price it increased by 12 per cent and then
decreased by 12 per cent. Would they have the same price after two years? Why or why not?
Show computations.

Solution:

Solution:

Solution:

Solution:

15. Suppose that returns of Sunshine Company Limiteds share are normally distributed. The
mean return is 20 per cent and the standard deviation of returns is 10 per cent. Determine
the range of returns in which about 2/3rd of the companys returns fall.
Solution: